Ahead of an FDA Decision, Do You Buy This Stock?

Sherrie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Pharmacyclics (NASDAQ: PCYC) crossed $100 a share on Thursday, giving it a market cap of $7.4 billion and a one-year return of 73%. As the company prepares to seek FDA approval for its oncology drug candidate ibrutinib, has its valuation become too large to justify your investment?

Promising Yet Expensive

Pharmacyclics is at a crucial point in its history: It is seeking an FDA approval to treat mantle cell lymphoma (MCL) and chronic lymphocytic leukemia (CLL), two forms of blood cancer. Combined, Pharmacyclics is testing ibrutibib in seven different studies; if successful in all studies, the drug could generate peak annual sales of $3.5 billion.

While Pharmacyclics is partnering with Johnson & Johnson, Pharmacyclics still receives 50% of the profits, but is only responsible for 40% of the costs. However, with a $7.4 billion market cap, it reminds me of two other companies that had promising products and large valuations prior to their FDA approvals: Alexion Pharmaceuticals (NASDAQ: ALXN) and Dendreon (NASDAQ: DNDN). But which company will Pharmacyclics likely follow?

What You Don’t Know, Can Hurt!

Back when Dendreon’s prostate cancer drug Provenge was first approved, the company traded with a market cap of $6 billion. Today, it is valued at $720 million, as peak sales estimates for Provenge have failed to meet expectations of $1.5 billion. In addition, limited survival benefits of just a few months and a high price tag of $90,000 have encouraged physicians to use different drugs.

Last quarter, Dendreon hit a new low as sales declined 17.6% year over year, making its total revenue over the last 12 months just $311 million. Moreover, the company has an operating margin of negative 83.6% and has produced a net loss of $360 million.

At the time of Provenge’s FDA approval, many of the costs associated with its manufacturing were not considered, since they were unknown. Investors didn’t realize that producing Provenge was worse than manufacturing medical isotopes; its inability to be stored, the inability to produce several doses per blood drawl, and the high costs of maintaining its multimillion-dollar facilities were not considered such awful problems at the time of Provenge’s approval. Yet all have contributed to Dendreon’s failure.

Expensive, But Promising

Alexion Pharmaceuticals develops and markets the drug Soliris, which treats serious and life-threatening illnesses, including blood diseases. It treats paroxysmal nocturnal hemoglobinuria, which causes the destruction of red blood cells, and atypical hemolytic uremic syndrome, a rare genetic disease that causes organ damage. Soliris is also being tested in five other studies, all of which are rare life-threatening diseases.

When Soliris was first approved in 2007, Alexion traded with a market cap around $5 billion. Today, the company is valued at almost $20 billion with Soliris creating sales of $1.23 billion over the last 12 months.

If the company can prove that Soliris is successful in all of its clinical studies, then analysts expect peak sales north of $4 billion. The combination of Soliris being an orphan drug, having large sales potential, and being an early market success has led shares of Alexion significantly higher since 2007. Moreover, operating margins of 35% have allowed the company to convert much of its revenue to profit, which helps to support its large valuation.

Where To Go From Here?

Thankfully for Pharmacyclics, ibrutibib is a small molecule drug, not a drug that has to be manufactured per patient for every dose (i.e. Provenge). Therefore, ibrutibib is expected to have high margins, in the 20%-30% range. Pharmacyclics is responsible for just 40% of the total product costs associated with Ibrutibib. Yet, Pharmacyclics keeps 50% of the revenue. This ratio of higher revenue and lower costs will help to boost margins, which is crucial in assessing a company's valuation.

Ibrutibib also has the potential to cross into different indications, like Soliris but unlike Provenge. Therefore, with the potential for large sales and profits, I think Pharmacyclics could be more like Alexion versus Dendreon.

The only problem I foresee is that Pharmacyclics is more expensive than Alexion was when Soliris was first approved. Alexion was trading at 1.25 times peak sales of Soliris back in 2007. But with a $7.4 billion market cap, and with Pharmacylics set to receive half of ibrutibib’s $3.5 billion in peak sales, Pharmacyclics trades at 4.2 times its peak sales.

However, with Alexion trading at 5 times peak sales of Soliris, Pharmacyclics hasn’t quite priced in all of its upside -- although it's getting close. So while I do not think it will relive the horror of Dendreon, I don’t think it’s as promising as Alexion. I’d either wait for a pullback or seek opportunity elsewhere. Right now, it looks as though most upside is priced into Pharmacyclics' stock.

Sherrie Stone has no position in any stocks mentioned. The Motley Fool owns shares of Dendreon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus